CFOs wiser through trial and error

April 18, 2016

CFOs are being inundated with deals. The global M&A market has never been so active as now. Yet through trial and error, CFOs have become cautious during the financial crisis. "And that is completely justified", considers Joy van der Veer, business valuator of the year and core teacher at the Executive Master of Business Valuation of TIAS.

Together with Frans de Roon, (academic director) and Camilla van den Boom (researcher and teacher), he is connected with the TIAS FinanceLab where research is done into among other things value based management. The core question is: can business model canvases be translated to hard figures in a predictive setting? Which cash flows and risks can be predicted? And can risks then be mitigated?

"Extremely interesting matter, certainly now the Dutch business community is laying the emphasis on corporate venturing in order to find the business model of the future", thinks Van der Veer. "We have high expectations from the research and the affiliated model that we are working out. We will further test the model in 2016 and 2017, together with several CFOs." Financial top managers have not progressed so far with this type of value based management, he hastens to add. "For them that is unexplored territory. To say it crudely, they are more inclined to mind the store."

Sum of the parts

That has to be done differently, according to Van der Veer. In the future, such models should also make valuations of takeovers easier. "Because the future revenue model can be extracted from this straight away..." That also facilitates the valuation of assets that are to be taken over. "That still says nothing about the market, but you can already calculate the sum of the parts prior to a takeover. Handy tools for the CFO, for the price determination.

That same CFO has become cautious, notes Van der Veer. "Before 2008, I looked suspiciously at deals and how unbelievably easily acquisitions with borrowed money were concluded. As if risks didn't exist..." In the meantime CFOs have cleaned up the balance sheets, the motto is cash, cash and nothing but cash. "Now you see a catching-up effect arising after years in which the M&A market was at a virtual standstill. That effect can also be explained with logic. The accumulated war chest can be paid out to shareholders, who in turn have relatively few investment possibilities (extremely low interest). And why not use your cash position to create growth and eventually shareholder return by means of responsible acquisitions?"

Here, cash is like water. It wants to follow the most favorable and natural course. Moreover, according to Van der Veer, it is striking that due diligence processes are a lot tougher than before the crisis. "That is also a good development. Whereas merger and takeover experts used to only look at finance, tax and legal issues, nowadays commercial due diligence is also included in the standard package. This is executed by specialized consulting firms. The core question is: what exactly is the revenue model of the future?

In the years 2010 to 2013 we saw that there were fewer purchasing parties available and partly as a consequence of that businesses were being sold at lower price levels. Now you see the transaction prices rising again. And that is surprising, considering the economic conditions have only marginally improved." Why are purchasing parties prepared to pay up once again? "Synergy elements", argues van der Veer. "The room for negotiation is defined by the number of alternatives you have. For a buy and build strategy, one often wants to buy an existing platform that has virtually no equal. The more unique and appropriate to the existing business, the more money will be put on the table."

A helping hand

After the initial and natural enthusiasm of the CEO, CFOs are deemed to look critically at those synergy effects. "And by calculating the future revenue models exhaustively." Moreover, the low interest rate seems to be a helping hand for enterprises that are considering takeovers. "But what is cheap if you are unable to identify the risks associated with the takeover?", warns Van der Veer. "You will be committing yourself to the acquired platform for the longer term and the question is whether you will be able to continue to fulfill the repayment obligations that you concluded with the deal. So the question too is whether you will be able to realize additional cash flows with the takeover. CFOs should be leading the way with the sensitivity test, which is really a reality check. Will the organization not be plunged into distress too quickly if expectations do not unfold as envisaged?"

The CFO is more cautious. Not only has Van der Veer established that, but it is also shown by a CFO Survey by Deloitte. In spite of the fact that CFOs are more positive about their turnover expectation and the current economic situation, their willingness to take balance sheet related risks is barely increasing. This caution also expresses itself on the mergers and takeover market. For the CFO, the realization of growth by mergers and takeovers remains a realistic option, due to the low interest and available financing possibilities.

Yet the number of CFOs expecting more transactions on the mergers and takeover market in the coming 12 months is expected to remain stable at 79 percent. Moreover, more CFOs indicate that they are planning to divest businesses. In conclusion, Van der Veer responds: "I can only welcome that caution with respect to balance sheet related risks. Let the CFO take renewed courage. The CFO needs to temper the expectations. Let him or her be more conservative. There is no harm in that."

Master of Business Valuation

Joy van der Veer is core teacher at the Master of Business Valuation at TIAS. This program will help you develop your knowledge and expertise in business valuation for the next step in your career as a professional Business Valuator.